Wise investors don't buy McMansions

Eight years ago I published a real estate book titled “Buyer Beware”, in which chapter 3 discussed the folly of the building industry pumping out four- and five-bedroom McMansions when households were getting steadily smaller. I dubbed Australia The Land of the Spare Bedroom, having estimated there were six million surplus bedrooms in the nation.

The situation has got worse, not better. Home builders have persisted with big houses, in defiance of demographic trends and the ability of families to afford houses that have got larger and more expensive.

Now the building industry is paying the price for refusing to adapt to society’s changing patterns. The Housing Industry Association and the Master Builders Association are the loudest whingers in real estate, bemoaning the lack of new home sales and pointing the finger of blame at various levels of government.

But, as they say, when you point an accusing finger at someone, there are three fingers pointing back to yourself. The real culprit in this is the building industry. I recall visiting a major display village in Sydney and asking sales consultants for one of the big-name builders whether they had a two-bedroom house in their portfolio. The conversation went like this:-

Them.: “A two-bedroom house … Why?”

Me: “Because I’m single.”

Them: “Well, we wouldn’t have anything that small.”

Me: “Why not?”

Them: “Well, there’s no demand for it … mind you, half the people who come in here ask the same question.”

Consider the contradiction in that last statement. Half the visitors to the display centre were asking for a smaller product but the builders reckoned there was no demand for a smaller product.

At the time I was living alone. I had no use for a four- or five-bedroom house and I didn’t want to pay for a 250m2 house when something half the size would be more than enough (and I didn’t want to live in an apartment).

I was reminded of this by Brisbane analyst Michael Matusik who has devoted one of his regular series of The Matusik Snapshot to the topic of why first-home buyers are not opting for new houses. His conclusion was this: “We are building the wrong homes!”

Matusik says there’s no reason why new houses can’t be provided for between $275,000 and $300,000 across most Australian cities. Developers and builders are missing the mark – and the market – by continuing to build large, expensive houses with front-loaded garages.

“At last count, the average new house was 35% more expensive than an older one (built under five years ago) in the same vicinity,” says Matusik. “One would expect a 10-15% differential given all the goodies in a new dwelling today, but at 35% more, new residential property is way too expensive relative to secondhand stock.”

Matusik believes limited land supply, restrictive planning practices and taxes & charges are partly the cause. But he says the development industry needs to take some of the blame.

“They build the wrong homes,” Matusik says. “And their marketing campaigns often don’t hit the right buttons when it comes to today’s first-home buyer.”

Matusik strongly believes we need more land supply to help make housing more affordable. Thirty years ago, he says, the land content of a home’s value was around 40%. Today it’s about 80%. Real building costs have remained fairly constant.

He also sees a need to increase the rate of building and to change the product. He makes these points:-

Of the 300 display homes in Queensland, only eight are under 200m2. It’s similar in other states. With building costs around $1,000/m2 for houses, very few display homes can be bought for less than $400,000 (including the land cost). Low-to-moderate income earners cannot afford to buy a new home.

Most residential estates have house size covenants starting at 180m2. Many have covenants over 225m2.

The average size of a new house in the mid-1950s was half the size of a new house today. Between 1985 and 2008, the average floor area rose from 170m2 to 250m2. This expansion has been occurring at a time when the average number of people in first-home households is shrinking.

In 1970 the average new house had 40m2 of floor space for each occupant; today each occupant has 85m2.

According to the 2006 Census, 42% of Australian households have two or more spare bedrooms.

There has been little change in the suburban lot sizes over the last 10 or so years. Allotment frontages are unnecessarily wide to accommodate cars. Developers are designing houses around the car, rather than the occupants.

So, what can be done about it? Matusik’s suggestions to make new houses more affordable include these:-

Relocate the car accommodation from the front of the property to the side or the rear – it’s cheaper and it creates more backyard space. It also allows smaller allotment sizes which can shave up to $150,000 off the purchase price.

Replace the garage with a carport, which can cut up to $50,000 off buildings costs.

Shrink the size of the house. Innovative design allows three-bedroom houses between 120m2 and 150m2.

“Think smart, not big tailored shoe boxes,” Matusik says. “It’s already happening in the US, where 89% of the new homes built last year were smaller than homes built by the same builder the year before.”

Perhaps the message is slowly getting through. My local newspaper, the Sunshine Coast Daily, reported on 17 March that some builders were actually lifting their rate of sales of new homes, in defiance of the economic conditions, by adapting their products to make them simpler and cheaper.

Sunshine Coast builders also disagreed with the notion that slow council approval processes were a major part of the problem. According to builders quoted in the article, the local council “provides a good service” and there is no backlog of applications awaiting approval.

The message in this for property investors is to avoid buying new homes until the building industry starts providing products that reflect demographics trends and affordability issues.

The reason master-planned estates are out-performed on capital growth by downmarket suburbs nearby is that the master-planned development is full of new, large, expensive houses. Buyers of these products are paying 30%-to-40% more than buyers of similar quality (but secondhand) homes in established suburbs next door – and if forced to sell soon after buying will lose money, because the general market can buy a similar product for much less.